Problem
Klump Trekkers, Inc., manufactures engines that are used in recreational equipment, such as motorcycles and personal watercraft. The company currently assembles the camshafts for these motors in its assembly department, which employs 40 skilled technicians. Due to crowded plant conditions and a shortage of skilled technicians, Klump is considering outsourcing the camshaft assembly to Mercury Motors, a specialist in the fi eld. Mercury would supply 125,000 camshafts at a price of $88 each. Mark Tobian is studying the proposed outsourcing deal and has prepared the following analysis.
Savings:
1. Reduction in assembly technicians ($32,500 x 36) $1,170,000
2. Supervisor transferred 43,000
3. Purchasing clerk transferred 19,000
4. Floor space savings [(1,500 x $12) 1 (6,000 x $10.50)] 81,000
5. Reduced purchase orders (1,200 x $1.40) 1,680
Total savings $1,314,680
Costs:
6. Increased component cost [125,000 x ($88.00 - $79.50)] 1,062,500
7. Hire junior engineer 28,000
8. Hire quality control inspector 26,000
9. Increased storage cost for safety stock (12% x 125,000 x $3.25) 48,750
Total costs 1,165,250
Net annual savings $ 149,430
Additional information Tobian has gathered includes the following:
• Of the 40 technicians employed in the assembly department, 36 will be let go. Four technicians will be retained and transferred to the fi eld service department to perform repair work. The supervisor of the assembly department will be transferred and promoted to assistant fl oor supervisor. No such position currently exists in the plant.
• A junior engineer will be hired to act as a liaison between Klump and Mercury, to ensure technical conformity. A quality control inspector will be hired to monitor Mercury's adherence to quality standards. The clerk in the purchasing department who handled all the camshaft purchasing will be transferred to an open clerical position in the sales department. Funds are available in the sales department to cover this position.
• The standard cost of producing a camshaft is as follows:
Direct materials $36.00
Direct labor 14.50
Variable manufacturing overhead 11.60
Fixed manufacturing overhead 17.40
Total cost $79.50
• The 6,000 square feet of space used by the assembly department will be converted to storage space. Currently, the space is valued at $10.50 per square foot. For the past year, Klump has been renting 1,500 square feet of storage space in a nearby building for $12.00 per square foot. This space will not be needed after the assembly department space is freed up.
• Management wants to increase safety stock levels from the current 8% of projected volume to 12% of projected volume. The variable cost to store the camshafts is $3.25 per camshaft.
• Klump will no longer need to issue the 1,200 purchase orders for camshaft materials. The variable cost of issuing a purchase order is $1.40.
Required
a. For each of the nine items listed in Tobian's analysis, indicate whether the item should have been included in the analysis. If the item is not appropriate to the analysis, explain why it should not have been included. For those items that are appropriate to the analysis, indicate whether the amount Tobian included is correct or incorrect. Use the following format for your answer: Item Number Appropriate/Inappropriate Correct/Incorrect 1. 2. 3.
b. What would be the financial impact on Klump of outsourcing the camshaft assembly to Mercury?
c. What other factors should Klump consider before making the decision to outsource the camshaft assembly?